Saudi Arabia and its OPEC allies face a test of their resilience when they meet next month. On the one hand, restricting output has boosted prices, but on the other hand their strategy has stoked production outside the group.

The Saudi insistence on rigid output discipline isn’t without risk in Asia.

Riyadh has so far maintained its market share in the region, despite its self-enforced production cuts. For instance, supplies to China in January rose 34 per cent year on year to 1.4 million barrels per day (b/d), official government data showed.

But, an open arbitrage to Asia for US, North Sea and West African crudes, and the possibility of global demand growth picking up momentum increasingly threatens the kingdom’s carefully crafted strategy. For now, the Saudi’s are sticking to their game plan. Riyadh cut output to 10.15 million b/d in February, according to an S&P Global Platts survey. That was 160,000 b/d below its quota of 10.31 million b/d and the lowest level since May 2018. Energy minister Khalid al-Falih has warned output could go lower in March, to 9.8 million b/d.

He has good reason to talk tough. Riyadh’s economic strategy is centred on higher spending. In order to have any hope of balancing its books, analysts say it needs oil prices above US$84/b (Bt2,685) for the entire year, at the very least.

Saudi cuts come at a time when the world is feeling the pinch of medium and heavy sour crude volumes lost from Venezuelan and Iranian sanctions.

S&P Global Platts Analytics forecasts that US sanctions will cause Venezuelan output, which averaged about 1.10 million b/d in February to fall to 825,000 b/d in the fourth quarter of this year before dropping to an average of 750,000 b/d in 2020.

Meanwhile, Iranian crude remains in demand for now. According to a Platts survey, Tehran kept output steady in February, at 2.72 million b/d as several buyers took advantage of sanctions waivers the US granted to eight countries to keeping purchasing its crude. These waivers are set to expire on May 5 and a further extension looks uncertain.

Reflecting the Middle Eastern sour crude market’s strength, the Brent/Dubai Exchange of Futures for Swaps – a key indicator of Brent’s premium to the Middle Eastern benchmark – averaged 51 cents/b in February. This marks the lowest monthly average premium for the European benchmark on record, according to Platts data.

A narrow Brent/Dubai EFS spread implies that medium to heavy sour Dubai-linked crude grades are getting relatively pricier compared to lighter, sweeter Brent-linked crude grades from the North Sea and West Africa.

US oil growth

A flood of North American oil is gnawing at Saudi resolve.

US crudes are attracting the attention of plenty of Asian buyers. Various flagship North American export grades have been consistently trading at a steep discount against comparable light and medium Persian Gulf grades.

China’s state-run Sinopec has increased interest in US crude oil purchases after a lull of several months and more US VLCC oil deliveries are expected as early as May.

According to S&P Global Platts Analytics, US shale oil is poised to respond to tightness in the market if needed. A new 2 million b/d of pipeline capacity being added in the second half of 2019 also helps.

The International Energy Agency in its February report noted that US crude production alone this year is expected to grow by more than Venezuela’s current output of around 1.26 million b/d.

So it’s no surprise that after a gain of $5-6/barrel to over $67/barrel in February, front-month ICE Brent futures have since stabilised around the $65/barrel level. Platts Analytics expects the price to reach $70/barrel in the fourth quarter of the year but says that higher US shale oil growth poses a bearish risk.

Although Venezuela’s government is teetering, its crude remains in demand in Asia. Indian and Chinese refiners – the main customers of Venezuela’s state-run PDVSA in Asia – face difficulties in ramping up imports of the Latin American country’s crude from current levels. US sanctions, payment restrictions and shipping problems have complicated life for traders.

Asian refiners accounted for around 40 per cent of Venezuelan crude purchases before the US Department of the Treasury imposed sanctions on PDVSA on January 28.

Given that the arbitrage window for Brent-linked crudes is still wide open and there’s a gap in Venezuelan supply, Saudi Arabia will need to think hard about maintaining production cuts.

It was against this uncertain backdrop that a key six-country OPEC/non-OPEC market monitoring committee co-chaired by Saudi energy minister Khalid al-Falih and his Russian counterpart Alexander Novak met on March 18 in Azerbaijan. The full coalition will again gather in Vienna on April 17-18.